Jenga Magnified

Federal Reserve Chair Janet Yellen’s tactical assessment of the U.S. economy’s potential ability to manage a rate increase this year, coupled with buttressing support from Fed Vice-Chair Fischer, effectively triggered the largest one day swing in equity index performance for the month of August on Friday. Truthfully, the message sent to investors to expect a move in rates this year was initially branded by San Francisco Fed President Williams and by New York Fed President Dudley previously and as was discussed in Thursday’s note. The comments by Yellen and Fischer on Friday however managed to trigger a modest increase in intraday volatility due to the fact that Fischer indicated that there may be two moves by the Fed this year. By the close, equity markets produced a mixed close. The Dow Industrials lost 0.28% while the S&P 500 gave back 0.15% and the Nasdaq inched 0.13% higher. Given the fact that the Dow was more than 100 points higher at midmorning, a negative close is noteworthy. Additionally, volume on both the NYSE (+13.48%) and Nasdaq (+6.6%) picked up, in the process delivering another distribution day.

Our equity market uptrend remains under pressure.

One sector of the market that provided some lift on Friday was the financial sector. The US 10-year rallied 3.68% to close at 1.6350. Of course, any increase in the chances of a rate increase is good news for banks and financial institutions as ongoing NIM compression has kept earnings acceleration well contained – despite a relatively healthy employment picture. For the same reason that financials gained ground relative to the broader market, exporters once again came under pressure – due to the relative strength of the dollar.

We have an enormously important economic calendar ahead of this week. Clearly Thursday is the busiest day of the week but Friday will be the focus point. As outlined below (Bloomberg), we receive August’s employment report.

Given the centrality of the employment data to any prospective move in rates over the balance of the year, Friday’s employment data is huge.

Stronger than expected gains will lead investors to price yields across the board accordingly – higher. The impact on financials will be efficient and positive. If however, there is more strength in the week’s economic data than expected, coupled with stronger than expected employment gains, investors will grow increasingly concerned that Fed Vice-Chair Fischer’s call on Friday for the potentiality of two rate rises this year may materialize and trigger further selling. It is all a balancing act and everything is interconnected.

Flickr photo: p_a_h_
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